Is Sprint Crazy or Is Tidal’s Streaming Platform Worth the Money?

The country’s fourth largest wireless carrier, Sprint Corp. (NYSE: S), announced this morning that it had agreed to acquire a one-third interest in streaming music service Tidal, an artist-owned service run by rap star Jay Z, for a reported $200 million. Perhaps not since Apple Inc. (NASDAQ: AAPL) paid $3 billion for Beats has a company overpaid so much for a music company.

Tidal trails far behind both Apple Music and industry leader Spotify in paid subscribers. Last Friday an Oslo, Norway, newspaper said Tidal’s reported subscriber number of 3 million is too high by a factor of three. If Sprint paid $200 for each of Tidal’s subscribers, then Spotify, which ended 2016 with 89.1 million paid subscribers, is worth nearly $18 billion based on a similar per-subscriber calculation.

Spotify is expected to launch an initial public offering (IPO) this year. When the company floated a $1 billion convertible loan last summer, the company’s valuation was set at $8 billion. If Spotify does offer an IPO by March, the interest rate on the loan rises from 5% to 6%, and rises by an additional 1% every six months that no IPO is held. The cap on the interest payment is 10%. The coupon on the debt may be converted to shares at a discount of 20% to the IPO price, and Spotify is further penalized by an additional 2.5% discount for every six months there is no IPO.

Spotify’s problem is not subscribers and revenue but profits. Spotify’s content costs ran to 84% of revenues in 2015. That’s on a par with streaming video giant Netflix Inc. (NASDAQ: NFLX), but Spotify’s total costs run about 9% higher than revenues. Netflix’s total costs as a percentage of revenue ran to 82% in 2016.

Tidal reported a $28 million loss in 2015 on revenues of $43 million. That the service lost money is not the point. Every streaming music service loses money, and only Apple and Amazon.com Inc. (NASDAQ: AMZN) can afford to keep losing money for as long as it takes.

The point is the size of the numbers. 2016 numbers aren’t publicly available yet, but exclusive deals on new music by Rihanna, Kanye West and Beyoncé almost certainly will have boosted the top line. But assume that the company had 3 million subscribers and $43 million in revenues. That’s an average approaching $15 per subscriber, compared with Spotify’s average of nearly $76.

Tidal’s problem is churn. It can sign up subscribers but it can’t keep them. The exclusive deals work once, then the impact is gone and so are the new subscribers. An injection of dollars from Sprint is unlikely to solve Tidal’s basic problems: a defective business model and some really big entrenched competition. The only reason exclusive deals work at all, even for Apple, is because they are good promotions. Even with Sprint in its corner, Tidal can’t lose money as fast as Apple can and still stay in business.

Investors, however, seem pleased with the deal. Sprint shares were up 3.4% early Monday afternoon, at $9.23 in a 52-week range of $2.44 to $9.25, and the high was posted in the morning. The 12-month consensus stock price is $7.28.